Credit risk modelling: An empirical analysis

Abstract

Default risk is the risk faced by the financial institutions relating to the uncertainty in the ability of its customer to service its debts and obligations. It is impossible to distinguish between the firms that will default and that will not before the default has happened. However it is important for these financial institutes to have a probabilistic assessment of what would be the likelihood of default. Credit risk modelling framework uses the causal dependence of potential bankruptcy of the borrower to its financial attributes. In a popular model proposed by Robert Merton as a logical extension of the Black-Scholes option pricing framework, he explains how the credit risk of a firm can be obtained by considering the firm’s equity as a call option on its assets. In this Project, we have tried to develop a model for predicted the probability of default of companies using a similar method and thus implement a credit risk model that may be used by financial institutions to gauge the credit risk parameter for a certain company